Performance Based Contracts: Are they worthwhile?

November 17, 2014

IACCM recently completed research with Newcastle University Business School and the University of Paderborn, exploring industry experience with performance or outcome-based contracts. Complete findings will be published shortly, but the results indicate that the use of performance or outcome based contracts remains relatively immature, even though experience in many cases is favorable. There is particular evidence that this approach to contracting results in more collaborative and longer term relationships, implying that they are capable of delivering increased value for both parties. However, success typically requires a level of investment by both parties in appropriate skills, processes and supporting tools or systems. Also, the level of adoption at present appears greater in contracts where payment is based on use, rather than those where payment is based on results over time.

Therefore any move by industry – or individual contractors – towards this contractual model requires a degree of planning and capability review; it also requires more careful and holistic review of trading partner culture, behavior and capabilities to ensure each party is equipped to operate with these models.

The survey – which gathered input from more than 250 organizations – reveals that most performance-based contracts are being constructed through ‘trial and error’ methods and then demand ‘improvisation’ for their on-going management, often including the need to challenge or change internal policies or practices.

Many performance / outcome based agreements today are quite rudimentary and for relatively standard, low-value services. This is reflected in the payment schedules, where rewards are mostly not based on outcomes, but on pay by use. This confirms the fact that many performance based agreements are more about turning services into commodities, rather than operating at a strategic level of delivering high value outcomes.

However, with some two thirds of respondents reporting favorable or very favorable results, it is clear that interest in this relatively immature type of contract will continue to increase. IACCM’s work has been focused on the approaches and structures needed to support success.